Ridham Desai, Head-India Equity Research & India Equity Strategist, Morgan Stanley in an interview to CNBC-TV18 explained the details of his market report. It is an interesting report on digitisation and its benefits and the next billionaires that will be created out of that.
In the report, he talks about the big digitisation push leading to huge surge in GDP, which will reach USD 6 trillion and equity market cap rising to USD 6.1 trillion.
According to him because of digitisation and the GST wave currently underway, the Sensex is headed to 1,00,000 by 2027 as a base case and as a bull case to 1,30,000.
Below is the verbatim transcript of the interview.
Anuj: This looks like a special report that you have come out with, but you are talking about this big digitisation push leading to huge surge in gross domestic product (GDP). You are talking about GDP to reach USD 6 trillion, equity market cap to rise to USD 6.1 trillion but for now the market is not listening.
A: Let us come back to the fore now a little later. Let me explain to you what we are trying to do. This is a truly global report. We have tens of analysts from across Morgan Stanley’s research department who have collaborated, people have looked at what is happening in India and understood the implications on companies across the coverage universe of Morgan Stanley and we look at 3,500 plus companies globally. So there are far reaching implications of what is happening in India. Some of it is understood, I think some of it is less understood, so, the purpose of this report is to bring it all together.
There are two pillars on which India’s digital leap, which is the phrase we use, is happening. The first is JAM which I think is fairly well understood which is Jan Dhan, Aadhaar, and Mobile. A lot of that has been built in the last three years. Momentum on these three factors have come in the last three years, but people forget that in four or five years from now, there will be 700 million smartphones in India and there will be a billion people with internet access and this is a huge change from where we were say three years ago.
Almost every household in India will have a bank account and of course we have biometrically identified 1.2 billion people and the implications of that actually go beyond the stock market, they go beyond the economy. They go into areas such a security and I am convinced that a lot of countries are going to come to India and will want to understand our Aadhaar architecture because the Aadhaar architecture I think is a big breakthrough in terms of technology. Hats off to Nandan Nilekani because he has pulled it off.
Then the second leg is Goods and Services Tax (GST) which is much malign these days to the now question, but GST I think brings two big changes to the fore. The first is the way banks will lend in India. Latha has covered this for years, so she understands this a lot better than others, is that banks in India have hitherto lent on collateral; you put an asset on the table, you get a loan, and then you use it to fund your next project. That is going to shift and it is going to become cash flow based lending. Why has that not been possible in the past? It has not been possible because cash flow data in India is not available outside the top 20,000 companies. So banks cannot rely on filed statements because a lot of people in this country, a lot of firms have been evading taxes. So they don’t have authentic, good, cash flow data. That will change under GST.
Every month your cash flow will get updated on GST, you can authorise people to access that data directly from GST and therefore in about a year or two from now, banks will be in a position to assess cash flow and lend to that. This is big for micro and small enterprises who have been outside the formal credit system. So forget the top 25,000 companies in India, think about the next 8.9 million firms who have been accessing credit through expensive sources, will now come into the formal banking system. So credit to GDP I think will rise meaningfully and that is very important both for stock market returns as well as for the economy. So that is a big change.
The second is what could happen to revenues of the government. Now again there is a debate going around and I think it will take three to four months for the dust to settle before we know exactly what the governments’ revenues are, but our view is that revenues will actually go up because compliance will go up. The government can do two things with that revenue, it can either increase its spending or it can pay down debt. I think it will be a combination, but in large portion it will be paying down of public debt. We have got work in this report which shows that when public debt goes down, stock market multiples go up. Reason? Private investment gets crowded in.
For 70 years this country has experienced crowding out of private investments by government borrowing. Imagine when government borrowing starts falling, in fact not in terms of growth rate, but actually falls, debt to GDP actually falls, I think you will see a big change in the way private investment behaves. So these are the big changes coming out of GST which by the way just to remind everyone is a completely online platform. Nowhere in the world is tax system as online as it is in India. So nobody has done this before and JAM which also no one has done, so, India’s digital leap is not there anywhere else in the world and that leads to all these forecasts that you talked about.
Latha: I want to start with a gratitude and a caveat. Gratitude because we get bogged down by the day-to-day, hour-to-hour, minute-to-minute movement of stock market and you are standing out and trying to look at the larger picture. A caveat because every 10 years I hear this time is different and we have a 10 year or 30 year picture. I remember in 1991-1992, we had this India is the turnaround scrip and the liberalisation takes us to a new story. That gets muddied, by the time we came to even 1994-1995, we saw the global downturn, we saw a khichdi government coming in, and a lot of that early 90s advantage was lost. Early 2000s we had the big BRICs argument and saying tectonic shift, this time is different, emerging markets, again it gets muddied. So is this a straight line? Your assumption, 10 percent CAGR in nominal GDP, 22 percent CAGR in mutual funds, AUM, life does not move in a straight line.
A: Of course it does not. There is no claim that it is linear. I will make two points here. First I will ask you a question and then I will give you a response; actually I will give you two responses. Now my question is guess for me which has been the best performing stock market in the world in US dollar terms in the last 20 years.
Latha: Is it India?
A: It is. So if you made this forecast and probably nobody made this because sell-side research did not exist then.
Latha: Which stocks are you taking in that?
A: We take the common index for everyone which is MSCI India. So we take MSCI US, MSCI India.
Latha: But the stocks in that keep on changing.
A: The stocks change in every index. I have written an essay a few years ago called ‘The Ship of Theseus’ because the Sensex today is very different, vastly different from what it was in the 90s. In fact, only six stocks have survived, but the Sensex is still compounded at 15 percent. So whatever is there in the Sensex it gets rejuvenated.
However, that point aside, India has been the best performing market, so it has delivered, but the delivery has not been non-linear. There is no claim here in this report that we are going to get linear performance. In fact my point in the report is that the non-linear performance means that bulk of this 10 year performance will come in the next four-five years.
Now pause for a moment and think because the headlines that are doing the rounds is that I have said that the Sensex is reaching 1,00,000 in 10 years; actually in the report, if you read the fine print, it is 1,00,000 in five years because after that I think you will enter a bear market. So the returns will be front ended because the markets will tend to price in these changes a lot faster than as the changes actually happen.
Anuj: You talked about goods and services tax (GST) being one of the best reforms but do you think right now the kind of worries that the market has in terms of earnings impact that it may not be just one or two quarter impact. The fear that the market has is that it may have a one or two year impact in terms of near term earnings and in terms of a market which has already run up a lot and also demand destruction. Do you think those fears are well-founded?
A: Those fears are not unfounded. Just go back to June, when I was chatting with companies in June and with market participants, the fear was that come first July we will not be able to invoice.
Latha: And that turned out to be true for some people?
A: No but it not turned out to be true in large part. My kirana guy was telling me to buy the things I need because there won't be a supply for two months. I met him after few days and I asked him about it. He said everything is happening. So there has not been a single day of supply disruption, so let's give the due where it is. The second concern was that GST, it will be hard to upload and it will be hard to be file taxes. We are yet to come to that point so we will know. The third concern that has emerged is that there is a mismatch between revenues paid and credit to be given but that picture also is very fuzzy and will only be clear in the next three-four months.
The market concern is not misplaced because the fourth concern was that micro and small enterprises will suffer. Why? In large part a lot of them had their competitive advantage out of evasion of taxes and if that advantage goes away, they become uncompetitive which is why large companies were going to benefit because they are going to get more market share from the small and micro enterprises. If they suffer, there are job losses and that is a slowdown in growth which is why the government of the day was very keen to push this out and not delay it.
If this had not happened on July 1, I am fairly convinced it may not have happened at all because the impact is likely to continue for a year and hopefully, I think that is a bet of the government, that then it will fade away so that come 2019 when elections around, GST will not be an issue at all. So the timeframe of one year is a very reasonable one.
Anuj: So you are saying this correction that we are seeing is a buying opportunity in a long-term bull market?
A: The market has been correcting for a few months now. You should see this relative to emerging markets. Do not look at it on absolute Nifty. There is a big bull market out there; China is up 41 percent this year, emerging market index is up 25 percent in dollar terms. India is up 21 percent in dollar terms. So India is underperforming and that correction didn't start last month. It has started a few months ago.
The first concern, I think the markets are expressing GST concern in April, so we have been correcting on a relative basis since April. So yes, it has been doing on for four-five months and maybe we are now coming to the end of it but the absolute level of the Nifty still premise from what global equities do.
Anuj: But you are still advising your clients to use this to buy?
A: Yes. I think it is a question of timeframe. My clients are split between two categories; people who buy stocks with one-two year view and longer and those who are trying to trade the market with three-four months view. So the published view for the last four months is been that we are expecting returns to moderate and the second half is unlikely to be as good as first half and midcaps will suffer the most. So if you want to be there, be in largecaps and avoid midcaps. Let the froth settle down and I think we are now coming closer to the end but I do not think the end is here as yet. I mean the market hate to make these short-term calls because I am very woeful at it but I could see the Nifty lose a few more points before it trough out and then the point is does it come back in a V and that will hinge on what the US markets do in the last two months of the year.
So if the US markets are strong and if we are making new highs then yes, the market could come back in a V but if the US market also levelling off then the market may take a while to come back. But it is a good opportunity for long-term investors to engage and for most of your viewers, they should not bother with these things, just continue with their SIPs as diligently as they have done over the past several months. It has been a good outcome and it will continue to be a good outcome in my view.
Latha: Let me come to the specific stocks. You have Bajaj Finance, Edelweiss, HDFC Bank, ICICI Prudential, Kotak Mahindra Bank, LIC Housing, Mahindra & Mahindra Financial Services (MMFSL). You have largely, in fact entirely stuck only to financials. When you are going for a digitisation wave, is it not possible that something like an app or something like a marketing company, an Amazon variety or retail, V-Mart Retail, why have you stuck only to financials?
A: No there is also a list of consumer stocks. So I'll explain. We see these two as the most beneficial and let me explain this, so tolerate me for a few seconds or a few minutes. In financials there are two things that are happening. Firstly is that 70 percent of the system is currently owned by the state owned banks. We see that the state owned banks have a structural problem so the stocks will go up and down and the rallies can be quite big and the falls also can be quite big and they get to the range of 30-50 percent at various points in time, but they have become trading stocks.
The reason I sense that is that I do not see the government having appetite to put the reasonable amount of capital that these banks need to grow. They will backstop them so they will not fail, but I do not see growth coming. So they will give up market and who will take the market? Like they have in the last 10-15 years, the private sector banks. So this whole 70 percent, half of it maybe, is up for grabs. We see 300-400 basis points of market share shift every year for the next 10 years.
So the state-owned enterprise (SOE) banks eventually will settle down in the 30s in terms of market share. So all these banks and non-banks have this market share to grab in a market which in any case, nominally is growing at about 10-12 percent. So, you have a situation where the banks, because of structure of their sector and because of the benefits that I mentioned from GST which is the ability to grow your book now way beyond your traditional corporates into MSME because you have better data and this is the direct effect of digitisation. You can actually do 20 percent growth and if you are going to compound it 20 percent for 10 years, that is a humongous number. All these banks will be significantly bigger, point number one.
Point number two is that there is also a change happening in consumer lending which has already been in place for the last five years and is continuing to go forward which is that in India, the 20 and 30 somethings are culturally inclined to borrow from their future which is borrow money. They will spend their future today. I did not do it. In a large part, you have not done it. Our parents did not do it, but I am sure Anuj is doing it. And, all 20-30 somethings in my office are sitting on debt and our willing to borrow from their future incomes to spend today.
Now that has two consequences. The consequences on the banks first, because when they have a bigger market and mind you, consumer debt to GDP in India is just 15 percent. It is 100 percent in the developed world and in China and we are not even forecasting that we are getting there in the next 10 years. We are going to be a far cry from that number. Based on our forecast, India's per capita income will be around USD 4,100 which is high middle income group at which point a lot of consumption items also inflate.
So think about India's consumption basket today. Every Rs 100 that is spent in this country, Rs 60 gets spent on food because we are a really poor country. But as you go forward, the Rs 100 grows to Rs 110, food will not grow because there is only that much food you can eat. So the remaining Rs 40 is growing to Rs 50 which is 25 percent. On top of that, you are leveraging, so you are actually growing that faster. So non-food consumption will see rapid growth. I fear that we will underestimate what will happen. The market has got a little bit of a whiff of it which is why consumer stocks trade the way they trade because the market probably realises that it will underestimate.
So collectively the market's wisdom I think is not wrong here. You can always pick up your points to buy this because stocks do get cycles but that is the other story. So the list is populated with financials and consumption and then, the third part of the list is global stocks because a lot of global companies will benefit from what is happening in India and their earnings will get meaningfully impacted. I am already seeing for the first time in my career where my US analysts are changing estimates on their companies because of things that are happening in India. It has not happened before. India is becoming big.
Anuj: We are talking about digitisation but we are not talking about any IT company or any IT infra, any kind of company which benefits out of that. Are there companies which can benefit from this drive?
A: Certainly, there are. I am constrained by my coverage universe and also by market cap criteria because remember, this is going out to global investors. It is not just tailor made for Indian investors and global investors will require a certain size for investing.
Latha: IT would have them?
A: Not IT services. Traditional IT services I do not think has any angle here but new IT services companies that are looking at smack will certainly benefit but most of the largecap IT services in India have very small smack revenues and they have largely enterprise.
Anuj: Maybe you are restricted by the market cap criteria, but that can also be the other sector to look at.
A: Yes, certainly. There will be quite a few – Eric Schmidt had said this two years ago when he was in town in Bengaluru that the next Google will be born in Bengaluru and Latha kicked off here question with that how do I know what the next Google is. If I knew that, we would not be sitting here. But I am sure that there will be new companies that will come to the fore which will actually create a lot of wealth.
There will be companies in the space of wallets. There will be companies in the space of e-payments. There will be companies in the space of IT infrastructure as you said. So there will be. They are not in the listed space right now, but they may get listed over the next 3-5 years and end up creating a lot of wealth.
Anuj: To get back to that NBFC question once again. When I spoke to you two years back, you said do not just look at price to book, look at the return on equity (ROE) as well. But looking at this entire space, do you get a sense that as a sector, this is similar to what real estate was in 2007 or what IT was in the late 1990s or early 2000s that everyone wants to start an NBFC. Right now everyone wants to be in this business. Do you get a sense that only three or four companies will survive and will make it big and in others, we could be looking at a real big bubble?
A: We are in very early days. So you give very good examples, late 90s, IT, middle of the last decade real estate. You see how these things pan out. So firstly, the existing listed stocks go up because of paucity of supply. Then new supply comes to the market, new listings happen. Everybody wants to then set up an NBFC and then, you get bubble valuations and then it crashes. So we are somewhere in the beginning here. So in 2018, I am quite sure that there will be a lot more supply in this space. And it could go through a phase of consolidation, but we are still far away from that bubble period where everything gets fancy valuations and people start doing funny things with their valuations. So we have not gotten there. It is a little away.
Latha: The other complaint I have with your list, could be easy to pick holes is that you are driving with the rear view mirror. HDFC Bank has been the greatest performer for the last 20 years. Usually, things can saturate when the current leadership moves out. It could well be that an RBL merges with IndusInd Bank and becomes the biggest private sector bank. So is your list too, rear view oriented?
A: I think it is good that we debate. It makes me a little bit more comfortable because if we all agreed then there is something wrong. Secondly, just because something has done well in the last 20 years does not mean it will not do well in the next 10-15 years. India is a good example. We started off with that conversation that India has been the best performing market for the last 20 years. So do you turn bearish on India just because it has been a good performer?
I do not think that should be the criteria. I think it should be based on the assessment of the business model and where the valuations are. So, that is how this list has been arrived at. On your comment on rear view mirror, you need a rear view. Try driving without a rear view. There is a little bit of a rear view required and of course, you want to look in the front and I get reminded by Jim Morrison's song, you have got to look at the road ahead with your hands on the wheel. But you keep glancing at the rear view just to make sure you are not crossing the lanes and doing something nasty.
For the full discussion, watch video
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